All around the world hundreds of millions of people are
pushing for higher living standards, leading to increased consumption of
polluting resources. But the current consumption of fossil fuels, and related
air pollution, water pollution and public health costs, is unsustainable – and
governments around the world are acting.

With governments meeting in early this month for the Paris
climate conference COP21, stronger commitments are possible, although we do not
expect legally binding agreements on all parties to emerge from the talks.

With policy support, high investment in renewable energy is
set to continue: Though some governments have throttled back support following
inefficient overbuild, the trend points upward in the largest markets,
primarily the United States and China, and key new markets in emerging
economies like India, Mexico, South Africa, Turkey, and others.

With more players chasing development, and lower absolute
subsidies in many cases, we think renewable energy investment returns may fall.

We recently cut our mid-cycle outlook for Texas power
markets by 20%, primarily because of the state's huge pipeline of renewable
energy projects that we expect to go into service during the next three to five
years. There are more than 24.5 GW of active generation requests under review
for new-build wind generation through 2020, including 11 GW in the next two years,
with the state's primary grid operator, the Electric Reliability Council of
Texas.

Renewable Energy Economics Still Need Help

Renewable energy investment remains driven largely by policy
and public support. Some herald the dawn of grid parity for renewable energy,
but the reality lags the hype. The levelised cost of electricity is a measure
used to compare different types of energy production, representing the
per-kilowatt hour cost of establishing and running a power plant.
Renewable energy projects' levelised cost of electricity, or LCOE, in remains
significantly higher than LCOE for more-traditional power generation
technologies.

However, the rationale for renewable energy isn’t purely
economic in the classical sense, since classical economics ignore the massive
external costs of fossil fuel, particularly coal, consumption. Incorporating
these costs into our analyses shows the playing field is more even, though many
countries are slow to incorporate these external costs in their visions for
electric power systems.

Mandates and financial support are in flux: Financial
subsidies and government mandates have been the two pillars of support for
renewable energy. Financial subsidies in key markets such as China, Europe, and
the U.S. face increasing risks.

But there's potential upside from new policies: In the U.S.,
the Clean Power Plan, or CPP, could require aggressive renewable energy
development in many states as one possible path toward compliance if the CPP
survives legal challenges. Carbon emissions regulation in Europe has proven
mostly ineffective due to terrible design flaws, but the EU is considering
policy changes that aim to drive CO2 credits higher and incentivize investment
in carbon-free energy.

Europe's trajectory is the least attractive, sending its
multinationals scrambling: With schizophrenic policy and cuts to incentives, we
recommend avoiding exposure to European renewable energy development, relative
to that in other markets. Furthermore, Europe's multinational utilities are
desperate to rebrand themselves, increasing the risk of weak capital allocation
chasing development elsewhere and putting pressure on returns for all players.

Invest in Infrastructure

Implications for power systems are higher grid investment
even with weak demand growth: Renewable energy capacity should grow strongly
during the next decade, requiring substantial investment in electric grid
infrastructure – both distribution and transmission – to facilitate the new
assets and power flows. We view state renewable energy policy and the U.S.
Clean Power Plan as tailwinds for electric utilities growth.

In Europe, EU and national policies should support similar
grid investment needs. Transmission investment in the U.S. has a clear growth
runway, while Europe's transmission growth outlook is much less certain, given
the difficulty of financing large-scale projects.